Detroit bankruptcy exit plan threatens munis as pensions favored

By Bloomberg

Detroit's pensions would get more than twice what creditors who loaned the city money for those funds would receive under a proposal to restructure its $18 billion of debt.

The draft plan given to creditors last week by Emergency Manager Kevyn Orr offers different recovery rates for classes of unsecured creditors. Pension funds would get 45 to 50 cents on the dollar, though retiree health care liabilities would recoup just 13 cents, according to the plan.

The record municipal bankruptcy may set precedents in how retirees and bondholders are prioritized when a locality falls into distress. Investors in the $3.7 trillion municipal-debt market have assumed that states and cities would raise taxes as high as necessary to make full payments on general obligations.

Orr's plan, reported earlier by the Wall Street Journal, makes clear that unsecured creditors, with $9.2 billion in claims, would be treated differently in the bankruptcy, which came after the one-time industrial giant was unable to pay bills or provide adequate services. The proposal was given this week to creditors for feedback, as Orr prepares to submit a restructuring plan to federal bankruptcy court.

"If you're a bondholder in the state of Michigan, every pledge should be viewed as a subordinate pledge going forward," said Adam Mackey, head of munis at PNC Capital Advisors LLC in Philadelphia. "Ultimately you're going to see Michigan debt be penalized."

Saving masterworks

Loans of $1.4 billion made to shore up two pension funds would receive 20 percent of their claims, under Orr's plan. Investors holding $369 million in unlimited-tax general obligations would recover about 46 percent, and $161 million of limited-tax debt would get 28 percent.

Payments would rise slightly if the city leases its water and sewer system to a new operator, netting $1.5 billion over 40 years.

The plan assumes an infusion of $700 million for the two pension systems from equal contributions by the state and private foundations. To protect the city's collection of art masterworks, foundations and the Detroit Institute of Arts have pledged $470 million. Republican Gov. Rick Snyder has proposed $350 million that the Legislature must approve.

Stiffing banks

The deal to protect pensions and the artworks was panned by Fitch Ratings, which this week labeled it an "us versus them" mentality in Michigan by favoring retired state workers over bondholders.

The city also has proposed paying nothing to Bank of America Corp. and UBS AG, who hold secured, interest-rate swaps that have cost taxpayers $202 million since 2009. The city says it disputes the legitimacy of the swaps but might set aside about $4.2 million a month in a reserve fund in case a court finds them legal.

Bondholders would be repaid in the form of 30-year notes with a 5 percent interest rate.

Under the U.S. Bankruptcy Code, similar creditors normally are treated the same, which means that giving the pension funds more money than unsecured bondholders might be difficult to justify to a judge. There are ways around the general rule, however, bankruptcy attorneys say.

Orr's latest plan increases money going to unsecured creditors compared with an offer he made in June, before the city filed for bankruptcy protection. That proposed treating pension funds and bonds the same, both getting pennies on the dollar.

'Painful cuts'

While paying a better rate to pension claims, Orr's plan would result in "painful cuts" to retirees, which average $19,000 for those in the general employee system, said Jordan Marks, executive director of the Washington, D.C.-based National Public Pension Coalition.

"While Detroit's communities would fall further behind, big banks will feel little pain as Wall Street posted record profits in 2013," Marks said in an emailed statement.

Orr's plan also would create an independent trust for retiree health care, called a Voluntary Employees Beneficiary Association. The trust for current and future retirees would receive the $524 million to be paid under the settlement with unsecured creditors.

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